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|America's debt crisis -- making sense of the debate|
|Wednesday, 20 July 2011 08:54|
As we watch the battle between President Obama and the Republican-dominated Congress over America's public debt, we could get the impression that the great American nation was on the verge of collapse.
In reality, nothing could be further from the truth. America's real crisis is not about debt. It's the jobs crisis, and the hopeless future that many Americans have because of this.
Let's try to make sense of the debate. The President and Congress are now expending great energy fighting over a "debt ceiling". What is this debt ceiling? Based on the US Constitution, the US Treasury is authorized by Congress to issue debt to finance federal government deficits provided that a ceiling, determined by Congress, is not exceeded.
Now that financing the US deficit is hitting the present celing of $14.3 trillion, the Republicans, who are doing their best to make life difficult for President Obama, are refusing to increase the debt ceiling unless the President agrees to their conditions which are many and diverse depending on the Republican Congress member you talk to. They include not increasing taxes, cutting expenditure, and agreeing to a permanent cap on debt. All of these options would weaken the economy in the short term, thereby weakening President Obama's re-election prospects next year.
Increasing a government debt ceiling, even if it is self-imposed, may seem dramatic. But in history the US Congress has increased the ceiling on numerous occasions, and those conservative Republican-dominated Congresses have increased the debt ceiling on more occasions than the Democrat-dominated Congresses.
In short, lots of political games are being played. But does the US really have a major debt problem, and if so, who is responsible?
Let's start with the basics. Goverrnment debt, in the US and elsewhere, is used to finance government operations where government expenditures exceeed revenues, that is, where there is a deficit. Interest must be paid on this debt, and one day in the future debt must in principle be repaid. In other words, a deficit today has to be financed tomorrow, and if the debt drags on long enough by future generations.
Are deficits necessarily bad? No! If the deficit is because of government spending lots on investment (like infrastructure, education, or R&D), it could be a good deficit. In other words, borrowing is fine if it finances sound investment -- BUT, not if it finances consumption. That is why President Obama has been proposing substantial investments in infrastructure.
When looking at deficits and debt, we must also look to the future. Investment can bring future returns. But governments can also accumulate future liabilities. In all of our ageing societies, governments are building up pension and health care liabilities. For this reason, many argue that our governments should be running surpluses and getting rid of all debt, like the Australian government has done over the past few decades.
So how big is the US debt? US gross public debt is forecast by the IMF to reach 100% of GDP, this year, 2011. Enormous, it seems. But it much less than countries like Japan (204%), Greece (130%) and Italy (130%). It is around the same as France (99%), Portugal (97%), UK (94%) and Ireland (93%). It is also not that much higher than good old Germany with its 85%.
You also have to be careful about making comparisons with countries in Euroland. Part of their problem is that now they are part of the euro, they can no longer have a depreciating currency to solve their problems. By contrast, the US dollar and the UK pound can still move freely.
To whom do we owe all this money? One-third of it we owe to ourselves, that is, it is held by other federal government agencies, partly related to social security. About one-third of US government debt is held by foreign governments like China, Japan and the UK.
Should we be worried about the Chinese pulling the plug on our debt? If they did, the US dollar exchange rate would fall and interest rates would rise, possibly causing some damage to the US economy.
But these foreign governments should be equally, if not more, worried. It is not easy for them to off-load their US investments. A falling dollar exchange rate could hurt them more than us. And there is not much alternative to the dollar, while the euro is in the doldrums. The Chinese are investing more in Europe, but while they refuse to let their own currency, the RMB, appreciate, they are condemned to accumulating foreign reserves, and investing in the US, which is still the world's best safe haven.
A bit of US debt history helps us keep things in perspective. US debt was a bigger share of GDP, about 120%, just after World War 2. Then US debt declined as a share of GDP for more than three decades.
So who got us in this debt mess? It all started when Ronnie Reagan came into power with his Reaganomics. Debt then took off to the skies, belying any legend that the right wing is fiscally more responsible than the left wing. Then came along President Bill Clinton who did very well by reducing the size of the debt as a share of GDP.
And of course to end this tale was George "W" Bush who started two wars and gave a tax cut to the rich, and just put the bill on his credit card thereby sending national debt through the roof. "W"'s biggest disaster of all was the global financial crisis which meant that massive spending was also necessary to save the economy.
So now we have high unemployment and a wobbly economy, and the Republican-dominated Congress wants to tighten the screws on the government deficit and debt. They are now trying to play the responsible game, while credit rating agencies are threatening to downgrade the US. But is there any risk that the US would default on its public debt? No way Jose, unless the Congress were to decide explicitly to default. All US debt is denominated in US dollars, which the Federal Reserve can just print.
Does screwing down on government deficits and debt make any sense to future generations who will ultimately have to pay the debt bill? Arguably not. Whilst ever the economy is weak, unemployed workers and young job seekers are rusting at home in front of the television. Sure their future debt burden could be less. But without a job they can't help repay any of the national debt anyway.
Our generation is also bequeathing the future a national infrastructure which is in a lousy state. Just look at the state of our roads, railways and many of our airports.
So herein lies the win-win proposal regarding our deficits and national debt. Instead of cutting expenditure and cutting the debt, we should follow the Chinese example of spending big on infrastructure -- highways, high-speed trains, airports, education for the poor. It's embarassing that China has better infrastructure than the US. It also weakens the US economy.
After a few years of investing in infrastructure, we would have lots of workers who have done something useful, and also kept their skills alive. By that time, the economy would have fully digested the effects of the global financial crisis. The ultimate result would be a stronger economy which enable us to finance all the debt, even if debt continued to grow a little more in the mean time.
For the moment, we are weakening the eocnomy and weakening ourselves by this self-inflicted debt obsession. Ultimately, this will make the debt burden worse.
This is not to say that we don't have a debt problem. There are many calculations of scenarios of debt explosions in the future. The Congressional Budget Office has estimated a present trend scenario where public debt would more than double by 2035.
But we have many problems, not just debt. And the best answer ifor our debt problem s to not punish our poor unemployed and jobs seekers, but to create a stronger economy.
Ultimately a stronger economy is the best solution to our debt problem, as we saw in the high-growth 1990s, when the national debt was reduced substantially.